Question

Warehouse Incorporated is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 20%. The stock of Todd Mountain Development Corporation has a beta of 0.70 . Using the constant growth DDM, the intrinsic value of the stock is

A. 12.77
B. 4.00
C. 40.00
D. 37.50
E. 45.00

Answer 1

The intrinsic value of Todd Mountain Development Corporation stock is calculated using the Constant Growth Dividend Discount Model (DDM) and the Capital Asset Pricing Model (CAPM). The DDM factors in the expected dividend, the growth rate, and the CAPM derived required rate of return. Using these models, the intrinsic value of the stock is determined to be $40.00.

Step-by-step explanation:

The intrinsic value of the stock can be calculated using the Constant Growth Dividend Discount Model (DDM). This model takes into account the expected dividend payment, the growth rate of the dividend, and the required rate of return for the investor.

To calculate the required rate of return, we use the Capital Asset Pricing Model (CAPM), which considers the risk-free rate of return, the expected market return, and the stock's beta. The formula for CAPM is:

Required Rate of Return = Risk-Free Rate + Beta (Market Return - Risk-Free Rate)

Therefore, the required rate of return for Todd Mountain Development Corporation is:

5% + 0.70 (20% - 5%) = 15.5%

Now, using the DDM formula:

Intrinsic Value = Dividend Payment / (Required Rate of Return - Dividend Growth Rate)

Intrinsic Value = $3 / (0.155 - 0.08)

Intrinsic Value = $3 / 0.075 = $40.00

Therefore, based on the Constant Growth DDM, the intrinsic value of the stock is $40.00.